Virtual currencies: while it is appropriate for the Union legislative bodies to regulate virtual currencies from the anti-money laundering and counter-terrorist financing perspectives, they should not seek in this particular context to promote a wider use of virtual currencies

On 19 August 2016 and 23 September 2016, the European Central Bank (ECB) received requests from the Council and the European Parliament respectively for an opinion on a proposal for a directive amending Directive (EU) 2015/849 on the prevention of the use of the financial system for the purposes of money laundering or terrorist financing and amending Directive 2009/101/EC (note 1), hereinafter the “proposed directive”.

The proposed directive expands the list of obliged entities to which Directive (EU) 2015/849 of the European Parliament and of the Council (note 2) applies in order to include providers engaged primarily and professionally in exchange services between `virtual currencies' and 'fiat currencies' (understood in the proposed directive to be currencies declared to be legai tender [note 3]) and wallet providers offering custodial services of credentials necessary to access virtual currencies (hereinafter 'custodia' wallet providers') (note 4).
The proposed directive also requires Member States to ensure that providers of exchanging services between virtual currencies and fiat currencies and custodian wallet providers are licensed or registered (note 5).
The ECB strongly supports these provisions, which are in line with the Financial Action Task Force (FATF) Recommendations (note 6), given that terrorists and other criminal groups are currently able to transfer money within virtual currency networks by concealing the transfers or by benefiting from a certain degree of anonymity on such exchange platforms.
The use of virtual currencies also poses greater risks than traditional means of payment in the sense that the transferability of virtual currency relies on the internet and is limited only by the capacity of the particular virtual currency's underlying network of computers and IT infrastructure.

Digital currencies do not necessarily have to be exchanged into legally established currencies

In this context, the ECB also mentions that digital currencies do not necessarily have to be exchanged into legally established currencies.
They could also be used to purchase goods and services, without requiring an exchange into a legal currency or the use of a custodial wallet provider.
Such transactions would not be covered by any of the control measures provided for in the proposal and could provide a means of financing illegal activities.

The Union legislative bodies should take care not to appear to promote the use of privately established digital currencies

The ECB recognises that the technological advances relating to the distributed ledger technology underlying alternative means of payment, such as virtual currencies, may have the potential to increase the efficiency, reach and choice of payment and transfer methods.
The Union legislative bodies should, however, take care not to appear to promote the use of privately established digital currencies, as such alternative means of payment are neither legally established as currencies, nor do they constitute legal tender issued by central banks and other public authorities (note 7)

The ECB has several concerns

The ECB has several concerns as regards the differences that exist between what the proposal refers to as 'fiat currencies' and `virtual currencies', one of which is the volatility associated with virtual currencies, which is typically higher than with currencies issued by central banks or whose issue is otherwise authorised by central banks, as this volatility does not always appear to be related to economic or financial factors.
Other concerns are that:
(a) unlike the holders of legally established currencies, the holders of virtual currency units typically have no guarantee that they will be able to exchange their units for goods and services or legal currency in the future;
(b) the reliance of economic actors on virtual currency units, if substantially increased in the future, could in principle affect the central banks' control over the supply of money with potential risks to price stability, although under current practice this risk is limited.

Thus, while it is appropriate for the Union legislative bodies consistent with the FATF’s recommendations, to regulate virtual currencies from the anti-money laundering and counter-terrorist financing perspectives, they should not seek in this particular context to promote a wider use of virtual currencies.

Notes

1) COM (2016) 450 final.
2) Directive (EU) 2015/849 of the European Parliament and of the Council of 20 May 2015 on the prevention of the use of the financial system for the purposes of money laundering or terrorist financing, amending Regulation (EU) No 648/2012 of the European Parliament and of the Council, and repealing Directive 2005/60/EC of the European Parliament and of the Council and Commission Directive 2006/70/EC (OJ L 141, 5.6.2015, p. 73).
3) See recital 6 of the proposed directive.
4) See recital 6 and point (1) of Article 1 of the proposed directive.
5) See point (16) of Article 1 of the proposed directive.
6) See the ATF's 'International Standards on Combating Money Laundering and the Financing of Terrorism & Proliferation: The FATF Recommendations' (February 2012). See also the `FATF Report Virtual Currencies Key Definitions and Potential AML/CFT Risks' (June 2014) and the FATF `Guidance for a risk-based approach - Virtual Currencies' (June 2015). All documents are available on the FATF's website at: www.fatf-gafi.org.
7) See page 13 of the Explanatory Memorandum accompanying the proposed directive and recitals 6 and 7 of the proposed directive. See also the European Parliament Committee on Economic and Monetary Affairs' Draft report on virtual currencies (2016/2007 (INI)) of 23 February 2016.

Annex

Opinion of the European Central Bank of 12 October 2016 on a proposal for a directive of the European Parliament and of the Council amending Directive (EU) 2015/849 on the prevention of the use of the financial system for the purposes of money laundering or terrorist financing and amending Directive 2009/101/EC - CON/2016/49 (pdf, 68 K, 8 pp.),

Fifth edition of the Basel Anti-Money Laundering (AML) Index developed by the Basel Institute on Governance.
Among the European countries, the highest risk countries are Luxembourg, Serbia, Greece, Switzerland, Italy, Germany, Moldova and Bosnia-Herzegovina. The rankings for Slovenia, Estonia, Serbia and Finland have deteriorated significantly within this region

The Basel AML Index is an annual ranking assessing country risk regarding money laundering/terrorism financing.
It focuses on anti-money laundering and counter terrorist financing (AML/CTF) frameworks and other related factors such as financial/public transparency and judicial strength.
This is the fifth edition of the Basel Anti-Money Laundering (AML) Index developed by the Basel Institute on Governance.
The Basel Institute published the Basel AML Index for the first time in 2012 and has since then been the only non-profit organisation to create a research-based ranking focusing on the risk of money laundering and terrorist financing.
The Basel AML Index provides the following key features:

Overview of 149 countries according to their risk level in money laundering/terrorist financing

Basel AML Index 2016

The Basel AML Index 2016 Report summarises the key findings and provides a detailed explanation about our methodology.
See also what is new in the 2016 edition and the recent changes in our methodology.
Our annual review section outlines the main discussions and feedback received from external experts with academic, supervisory and law enforcement background.

What does the Basel AML Index measure?

The Basel AML Index measures the risk of money laundering and terrorist financing of countries based on publicly available sources.
A total of 14 indicators that deal with AML/CFT regulations, corruption, financial standards, political disclosure and rule of law are aggregated into one overall risk score.
By combining these various data sources, the overall risk score represents a holistic assessment addressing structural as well as functional elements in the AML/CFT framework.
As there are no quantitative data available, the Basel AML Index does not measure the actual existence of money laundering activity or amount of illicit financial money within a country but is designed to indicate the risk level, i.e. the vulnerabilities of money laundering and terrorist financing within a country.

What has changed from the 2015 edition?

The 2016 Basel AML Index covers 149 countries.
Four countries were removed from the 2015 edition of the Basel AML Index: Barbados, Samoa, Suriname and Swaziland.
They were excluded from this year’s rating due to insufficient data.
Sudan was added to the 2016 Basel AML Index as more data became available.
The methodology remains the same as the 2015 edition, when a key methodological adjustment was conducted.
It takes into consideration the modifications brought to the assessment mechanism of the FATF Mutual Evaluation Reports.
For the first time they include an effectiveness assessment in addition to the assessment of legal compliance with the FATF recommendations.
While last year five countries were assessed according to the new FATF methodology, this year’s edition includes 14 countries with the new FATF Mutual Evaluation Reports as a source for the Basel AML Index.

The Commission has today (5 July 2016) adopted a proposal to further reinforce EU rules on anti-money laundering to counter terrorist financing and increase transparency about who really owns companies and trusts.
The adoption of the Fourth Anti-Money Laundering Directive (AMLD) in May 2015 was a major step forward in improving the effectiveness of the EU's efforts to combat the laundering of money from criminal activities and to counter the financing of terrorist activities.
This Commission proposal is the first initiative to implement the Action Plan for strengthening the fight against terrorist financing of February 2016.
The recent terrorist attacks and the Panama Papers revelations highlighted the need for the EU to take further measures and step up its fight against money laundering and terrorism financing.
This proposal, amending the Fourth Anti-Money Laundering Directive, intends to complement the existing preventive legal framework in place in the Union, by setting out additional measures to better counter the financing of terrorism and to ensure increased transparency of financial transactions and legal entities.

1. Tackling Terrorism Financing

How does the EU currently tackle the use of the financial system for terrorist financing purposes?

The EU has set up strong rules to combat money laundering and the financing of terrorism, to prevent the EU financial system from being misused for these purposes. The Fourth Anti-Money Laundering Directive, adopted on 20 May 2015, set high standards to ensure that credit and financial institutions are equipped to detect and take action against such risks. For instance, it introduced a requirement for Member States to put in place national registers of beneficial owners, to ensure transparency around certain ownership structures.
The swift transposition and implementation of these new rules is the first key step. Member States have committed at the level of Finance Ministers to bring forward the date for effective transposition and entry into force to end 2016 at the latest.
Given the evolving risks, the Commission is today proposing some amendments to improve the current legislative framework, and speed up some other non-legislative initiatives.

What changes does today's proposal introduce to fight terrorist financing?

The Commission proposes a number of targeted amendments to the Fourth Anti-Money Laundering Directive.
The amendments will strengthen the following points:

They are public authorities that exist in every Member State. They collect and analyse information about any suspicious transactions spotted by banks, for instance, or any other relevant information related to money laundering or terrorism financing. If their analysis of a file raises concerns regarding possible criminal activity, they transfer the file to law enforcement authorities for further action.

How will the work of Financial Intelligence Units in the fight against terrorism financing be facilitated?

The access of Financial Intelligence Units (FIUs) to – and exchange of – information will be enhanced in two ways:

by introducing centralised bank and payment account registers: centralised registers at national level allow for identification of all national bank accounts belonging to one person, or other similar mechanisms such as "central retrieval systems". They are used by law enforcement authorities to facilitate financial investigations, including those relating to terrorism financing. The establishment of these centralised registers or electronic data retrieval systems in all Member States will rapidly provide FIUs (or other competent authorities) with information on the identity of holders of bank and payment accounts. In parallel, the Commission will look into the possibility of a distinct legal instrument to broaden the scope for accessing these centralised bank and payment account registers for other purposes (e.g. law enforcement investigations, including asset recovery, tax offences) and by other authorities (e.g. tax authorities, Asset Recovery Offices, other law enforcement services, Anti-corruption authorities). Any initiative would have to be accompanied by appropriate safeguards, in particular as regards data protection, and conditions of access.

by aligning the rules for Financial Intelligence Units (FIUs) with the latest international standards: FIUs play an important role in identifying the financial operations of terrorist networks across borders and in detecting their financial backers. International standards now emphasise the importance of extending the scope of and access to information available to FIUs (that information is currently limited in certain Member States by the requirement that a prior Suspicious Transaction Report has first been made by an obliged entity). The Commission proposes to amend the Fourth AMLDin order to enhance the access to information available to FIU's.

What can the EU do to further address terrorist financing risks linked to high-risk third countries?

Today, the Fourth AMLD requires obliged entities, such as banks and financial institutions, to apply enhanced customer due diligence measures (i.e. extra checks and monitoring of financial transactions in order to prevent, detect and disrupt suspicious transactions) when doing business with natural or legal entities established in "high risk third countries" (see also below). However, at present, Member States are not required to include, in their national regimes, a specific list of enhanced measures and thus various regimes – stricter and less strict – exist in this field.
Harmonisation of these measures at EU level will avoid or at the least limit the risk of forum-shopping between the different Member States, thus avoiding weak spots that could be exploited by terrorists to channel their funds in an out of the EU.
The enhanced measures proposed are fully compliant with the list of such actions drawn up by the Financial Action Task Force ("FATF"). The list of countermeasures set out by FATF should also be adequately reflected in Union legislation.

How can virtual currencies be used to finance terrorism and what can we do to prevent this?

Banks and payment institutions fall under the scope of the Fourth AMLD, which requires them to comply with specific rules, such as verifying customers’ identity and monitoring financial transactions. Virtual currency operators were initially not included in the scope of the Directive.
Virtual currencies are developing quickly and are an example of digital innovation. However, at the same time, there is a risk that virtual currencies could be used by terrorist organisations to circumvent the traditional financial system and conceal financial transactions as these can be carried out in an anonymous manner.
That is why the Commission proposes to bring virtual currency exchange platforms and custodian wallet providers under the scope of the Fourth AMLD, in order to help identify users who trade in virtual currencies. Bringing these two actors under the Fourth AMLD and making them "obliged entities" will ensure better controls, ensuring that they apply customer due diligence and contribute to preventing money laundering and terrorist financing.

What is the difference between a virtual currency exchange platform and a virtual wallet provider?

Virtual currency exchange platforms can be considered as 'electronic' currency exchange offices that trade virtual currencies for real currencies (or so-called 'fiat' currencies, such as the euro). On the other hand, virtual currency custodian wallet providers hold virtual currency accounts on behalf of their customers (by providing virtual wallets from which payments in virtual currencies can be done or received). In the 'virtual currency' world, they are the equivalent of a bank or payment institution offering a payment account.

Why not just ban virtual currencies?

Whilst several jurisdictions in the world, including some European Union Member States and the European Banking Authority, have issued warnings about the risks that virtual currencies may entail, none have actually banned them. Virtual currencies are often considered as a useful tool for international payment transfers, low cost money remittance and close to instantaneous payments. To date, virtual currencies represent an innovative but rather small market. The European Central Bank in its last report on virtual currencies (February 2015) concluded that virtual currencies entail certain risks but do not at this point in time pose a threat to financial stability due to their still limited size – around 70,000 transactions are made daily on virtual currency platforms, worth around €40 million. Obviously, responsible authorities will continue to monitor the developments in this area.

What are the risks linked to pre-paid cards, and how can they be tackled?

Whilst the Commission fully acknowledges that prepaid instruments can have a social purpose and are beneficial for many citizens, including for those who are economically vulnerable or financially excluded, it is also aware of the risks stemming from the anonymity of some of these cards. For this reason, the Commission proposes to amend the Fourth AMLD to minimise the anonymous use of these products.
Given the risk of terrorist financing, the Commission proposes to minimise the use of anonymous payments through pre-paid cards, by lowering thresholds for identification from €250 to €150 and widening customer verification requirements for payments ‘on site’. More stringent provisions will apply for prepaid cards used on the internet so that anonymous use will not be possible online. Proportionality has been taken into account, with particular regard paid to the use of these cards by financially vulnerable citizens.

What about prepaid cards issued outside the EU, that are used in the EU?

While the use of anonymous prepaid cards issued in the EU is essentially limited to the EU territory only, this is not always the case with similar cards issued in third countries. The proposal contains a provision to ensure that anonymous prepaid cards issued outside the EU can be used in the EU only where they can be considered to comply with requirements equivalent to those set out in EU legislation. This means that banks will carry out their checks and will have to refuse payments made with cards from countries that do not have sufficiently high anti-money laundering standards.
What other non-legislative actions will the EU take in the fight against terrorist financing?a) Support work done by Financial Intelligence Units
The EU will continue delivering operational support to Financial Intelligence Units (FIUs). FIUs in Europe exchange information and identify money laundering and terrorist finance activities by matching information on suspected transaction reports through a decentralised IT system called FIU.net. The FIU.net network was integrated into Europol on 1 January 2016, helping police authorities to fight against terrorist financing.b) Tackling obstacles to information exchanges between FIUs
A planned mapping exercise among FIUs to identify practical obstacles to access to and exchange of information will be advanced and accelerated. FIUs are also expected to interact closely with other enforcement authorities. In this context, the Commission will also further look at means to support joint analysis of cross-border cases by FIUs and solutions to enhance the level of financial intelligence. The EU FIU Platform – representing Member States FIUs - will provide the results of its analysis before the end of 2016. The Commission will propose new initiatives by mid-2017 to remove the identified obstacles and increase financial intelligence.c) Conducting a supranational risk assessment of money laundering and terrorist financing risks, in line with the provisions of the Fourth Anti-Money Laundering Directive
In order to avoid blind spots and respond to the evolving nature of terrorism financing, the EU will put in place a framework to analyse terrorism financing risks in a broader perspective. The aim is to analyse the risks affecting the internal market and propose mitigating actions, including Recommendations to Member States (on a "comply or explain" basis) to address such risks. The Commission has already designed the methodology for this assessment and started the analysis process. Such a framework should allow the Commission to develop, in addition to Recommendations to Member States, new policy initiatives at EU level which are both evidence-based and tailored to the actual risks.

2. Tackling transparency of beneficial ownership

What are the issues identified by the Panama Papers?

The Panama Papers revealed that complex ownership structures have been used to hide links to criminal activities and tax obligations. They demonstrated the need for enhanced transparency on the ultimate beneficial ownership of certain legal entities needed to be further enhanced. The fourth AMLD already sets out a comprehensive framework as regards the collection, storing of, and access to information on the beneficial owners of companies, trusts and other corporate vehicles.
The Panama Papers highlighted areas where further enhancements would be advisable. The amendments put forward address these issues and will improve the transparency of beneficial ownership information by clarifying or strengthening some of its features: what is registered (i.e. entities for which information is registered), where registration must take place (which Member State is responsible for registration of a given entity), who is granted access to information (clearer access to information on beneficial ownership), how national registers should be interconnected. In addition, the Commission today announced separately [LINK TO TAX IP] that it would explore ways for information on beneficial ownership to be automatically exchanged between Member States' tax authorities.

Who will have access to the beneficial ownership information?

Currently, under the fourth AMLD, the information about the beneficial ownership of companies and trusts is already accessible to competent authorities and obliged entities in view of facilitating the performance of their "customer due diligence obligations" (i.e. a procedure consisting in properly identifying the customer on the basis of reliable and independent sources, such as for example identity cards or passports).
The Commission now proposes to also provide public access to certain essential beneficial ownership information held in registries regarding companies and trusts that engage in economic activities with a view to gain profit. For privacy reasons, access to information in relation to trusts not engaged in economic activities (e.g. family trusts set up to finance studies) will only be granted to persons and organisations that can demonstrate a legitimate interest.
Today's Communication on promoting tax transparency and fighting tax evasion also sets out our plans to make this information available to tax authorities, giving them all the information they need to crack down on those who do not pay their fair share of taxes.

What impact will the proposal have on the transposition of the Fourth AMLD by the Member States?

The formal transposition date for the fourth AMLD is 26 June 2017. In its Action Plan to strengthen the fight against terrorism financing of 2 February 2016, the Commission called on Member States to bring forward the date for effective transposition of the Directive to Q4 2016.
Although Member States have sped up work, the period to transpose the fourth AMLD is still ongoing. Therefore we must carefully take into account the work already undertaken by the Member States when implementing and transposing rules that are closely linked to the issues that will be revised by the modifying Directive, such as for example the exemption regime for pre-paid cards.
In this respect, continuity must be ensured with the work already undertaken by the Member States regarding the creation of the registries/mechanisms mentioned in articles 30 and 31 of the Fourth Anti-Money Laundering Directive.

3. Protecting the EU financial system from high risk countries

Why does the Commission intend to adopt a list of high risk third countries?

The Fourth Anti-Money Laundering Directive mandates the Commission to identify "high-risk third countries" having strategic deficiencies in their regimes on Anti-Money Laundering (AML) and Countering Terrorist Financing (CFT). The purpose of this list is to protect the proper functioning of the EU financial system from the money laundering and terrorist financing risks emanating from those countries. This requirement follows the approach developed at global level by the Financial Action Task Force (FATF) to respond to the threat posed by countries that did not implement internationally agreed standards on AML/CFT.
In line with the risk-based approach, banks shall apply enhanced due diligence in case of financial flows to/from high risk third countries identified by the Commission.
Those enhanced measures will lead to extra checks and monitoring of those transactions by banks and obliged entities in order to prevent, detect and disrupt suspicious transactions. Hence these measures do not entail any type of sanctions, termination of business relationship, restrictions trade relations, or limiting our development assistance; it only aims to apply enhanced vigilance measures in those cases. The EU will continue to engage across all relevant policy areas with the concerned jurisdictions, including through development cooperation, the ultimate goal being their compliance and removal from the list.In order to further clarify the type of enhanced vigilance to be applied and avoid loopholes in the EU, the Commission proposes to harmonise those enhanced measures through a revision of the Fourth Anti-Money Laundering Directive.

When will the list of high-risk third countries be applicable?

The Commission plans to adopt the Delegated Act identifying high-risk countries on 14 July 2016. According to the Fourth AMLD, the Delegated Regulation will then be transmitted to the European Parliament and Council who can express objections within a given period of time. The Delegated Regulation will enter into force if no objection has been expressed either by the European Parliament or the Council within a period of one month of the notification – which can be extended on request by one additional month (i.e. maximum 2 months in total) and the Delegated Regulation will be published in the Official Journal after this period and enters then into force.

The Wolfsberg Group of International Financial Institutions has produced a guidance document on SWIFT Relationship Management Application ("RMA") to supplement the Wolfsberg Correspondent Bank Principles issued in 2014.
This document is intended to provide broader guidance for managing noncustomer RMAs beyond the correspondent banking arena.

Guidance for a Risk-Based Approach for Money or Value Transfer Services

Money or Value Transfer Services (MVTS) play an important role in the international financial system and in supporting financial inclusion.
In December 2015[1], the United Nations estimated that developing countries received over USD 400 billion in remittances from migrants living abroad in 2014.
However, like other financial institutions, MVTS providers are also vulnerable to the abuse for the purpose of money laundering and terrorist financing.
The FATF has updated its 2009 Guidance on a Risk-Based Approach for Money Services Businesses to bring it into line with the 2012 FATF Recommendations.
This non-binding Guidance is intended to assist countries and their competent authorities, as well as the practitioners in the MTVS sector and in the banking sector that have or are considering MVTS providers as customers, to apply the risk-based approach associated to MVTS.
The risk-based approach, the cornerstone of the FATF Standards, requires that measures to combat ML/TF are commensurate with the risks. Such measures should not necessarily result into the categorisation of all MVTS providers as inherently high-risk.
The overall risks and threats are influenced by the extent and quality of regulatory and supervisory framework as well as the implementation of risk-based controls and mitigating measures by each MVTS provider.
While this Guidance is applicable to the entire MTVS sector (both banking and non-banking institutions offering MVTS); it is primarily intended for non-banking MVTS providers. This Guidance should be read in conjunction with other relevant Guidance, in particular FATF Guidance for a Risk-Based Approach: The Banking Sector.

Executive summary (note 1)

Since the Global Financial Crisis of 2007-09, the design and implementation of internal control systems has attracted serious academic and professional attention.
Much research on the effectiveness and characteristics of internal audit functions has been conducted under the sponsorship of the Institute of Internal Auditors Research Foundation (IIARF) and published in academic and professional journals.
Despite these efforts, there has been little systematic analysis of how the design of an internal control system affects the efficiency and effectiveness of corporate governance processes, especially at financial institutions such as banks and insurance companies.
The "three lines of defence model" has been used traditionally to model the interaction between corporate governance and internal control systems.
We consider the existing three-lines-of-defence model could be substantially enhanced by giving it a specific focus on the regulation of banks and insurance companies.
We address this deficiency and attempt to ascertain the extent to which these financial institutions - due to their idiosyncratic features and specific regulatory requirements - need a more effective internal control model.
Although our study relates to financial institutions in general, our detailed analysis focuses on banking institutions.
In order to account for the specific governance features of banks and insurance companies, we outline a "four lines of defence" model that endows supervisors and external auditors, who are formally outside the organisation, with a specific role in the organisational structure of the internal control system.
Building upon the concept of a "triangular" relationship between internal auditors, supervisors and external auditors, we examine closely the interactions between them.
By establishing a four-lines-of-defence model, we believe that new responsibilities and relationships between internal auditors, supervisors and external auditors will enhance control systems. That said however, we also highlight the risk that new problems could be caused by inadequate information flows among those actors.

Footnotes

1) The authors would like to thank the reviewers for the valuable comments and suggestions they received which helped improve the accuracy and validity of the investigation: Prof Robert Melville from CASS Business School, Prof Wilco Oostwounder from the University of Utrecht; and Juan Carlos Crisanto, Stefan Hohl and Raihan Zamil from the Financial Stability Institute of the Bank for International Settlements.

Contents

Executive summary
1. Introduction: the Global Financial Crisis, corporate governance and the three-lines-ofdefence model
2. Outline of the three-lines-of-defence model
3. Weaknesses and past failures of three-lines-of-defence model
4. The concept of the “four lines of defence” model in financial institutions
5. Relationship between functions of the third and fourth line of defence
5.1 Relationship between external auditors and supervisors
5.2 Relationship between internal auditors and supervisors
5.3 Relationship between internal auditors and external auditors
5.4 Transition from the three lines to the four lines of defence: the quest to design an effective
model for financial institutions
6. Conclusion

Issue no.4 - Looking at "Crying wolf" from a different perspective:an attempt at detecting banks under- and over-reporting suspicious transactions.
November 2015

Classificazione JEL: C25, G21, G28, K23
By estimating an econometric model, this study aims to assess, from a quantitative point of view, the flow of suspicious transaction reports (STRs) filed by Italian banks from each of the provincial districts they operate in. Regressors include (i) indicators of banks’ operational activities; (ii) measures of money laundering risk and (iii) proxies of economic activity, all of which at local level.
The analysis presents some technical challenges which are addressed by adopting a Negative Binomial setting, commonly used to model count data variables. In addition, observations are split into two sub-samples, according to each bank’s local scale of operation. Results show that the STR-filing strategies adopted by banks may be different from the ‘crying wolf’ approach, which is traditionally considered to be the most pressing threat to the effectiveness of anti-money laundering systems.
Furthermore, at a more operational level, the model provides a useful tool that supervisory authorities can deploy when checking the compliance of individual intermediaries with anti-money laundering reporting regulations.

Publication's text

Looking at ‘Crying wolf’ from a different perspective: An attempt at detecting banks under- and over-reporting suspicious transactions (pdf, 1.5 M, 28 pp.)

The alarm by Italian FIU regarding money laundering in Public Administration

On July 13th, 2015 upon the publication of the “Report 2014” by UIF - the Financial Intelligence Unit for Italy, the Italian anti-money laundering authority - the UIF Director, Claudio Clemente, stressed that “Italian public administration is particularly exposed to the incidence of corruption in procurement and public financing” but however, “it still shows little sensitivity to anti-money laundering despite having to respect AML requirements also regarding SARs obligations. This increases PA vulnerability.”
According to Clemente “ the enactment of specific AML indicators of anomaly for PA will increase its awareness of money laundering and will favor active cooperation of the public administration. PA anomaly indicators will be the fruit of collaboration between the FIU, ministries, ANCI – the Italian association of municipalities - and other authorities.
The PA anomaly indicators will report series of cases related to all sectors of public administration and another specifically aimed at high risk areas.
The procedure of SARs in PA is based on the identification of an explicit delegate.
The PA indicators will represent a major step intended to give a strong signal of the need for public administration to improve awareness of their role in the AML prevention system”(Clemente, “FIU 2014 - Presentation report ", 13 July 2015, p. 8).
Some days before, Claudio Clemente speaking at 11th congress of the Italian Compliance Association (AICOM) reiterated that cooperation against money laundering by public administration was still inadequate and called for more joint action between the FIU and ANAC - the Italian anti-corruption authority - to provide the PA with applicable rules apply and implement compliance processes in order to mitigate the risks of money laundering and corruption.

What are the indicators of anomaly?

UIF, the Italian FIU writes that “The ‘Anomaly indicators’ and ‘Unusual patterns in customer behavior’ are one of the support tools provided by Legislative Decree no. 231/2007 (the Italian AML Law – editor’s note) for the detection of AML suspicious transactions.
Even though they play an important role in the orientation of the obligated parties in the evaluation of operations, indicators and patterns are not intended to be either exhaustive or binding.
It is not possible to give a general definition of all cases which indicate money-laundering activity or terrorist financing; at the same time, the mere occurrence of one or more deficiencies listed in the indicators is not in itself sufficient reason for suspicious. This must necessarily be based on a full and weighted assessment all the information at the disposal of the obligated parties.

The text of AML anomaly indicators for Suspicious Activity Reports (SARs) in public administration

SARs figures regarding PA in 2014

In the "Report 2014" UIF underlines that regarding suspicious transaction reports “the contribution of public administration remains very modest in 2014 with 18 reports declined from 23 reports in 2013 (out of a total of 63.000) to 18 reports in 2014 (out of a total of 65.000).

The other "indicators of anomalies" and "diagrams representative of abnormal behavior"

The “Anomaly indicators” (art. 41, par. 2) consist of a list of examples of customer behavior to be considered "anomalous" and potentially characterize intent to engage in money laundering or terrorist financing.
The indicators are intended to reduce the margins of uncertainty associated with subjective behavior and also contribute to the containment of costs and the correct and consistent fulfillment of obligations to report suspicious transactions to the parties responsible.
It is the duty of the FIU to develop and propose the “Anomaly indicators”, which are then issued with formal measures by different authorities, competent according to the nature of the party responsible: the Bank of Italy for financial intermediaries and other entities operating in the financial field; the Ministry of Justice, for professionals, in consultation with the professional orders; the Ministry of the Interior (Home Office), for the remaining non-financial and public administrations.

Unusual patterns and diagrams of abnormal behavior

The “Patterns and diagrams representative of abnormal behavior” are complementary and integrate “Red flag indicators” (art. 41, par. 2) as a tool to aid the identification of suspicious transactions to be reported; they are developed and disseminated by the UIF, according to Article. 6, paragraph 7, letter. b) of the Decree.
In order to promote a more effective “active cooperation”, patterns and diagrams provide feedback to addressees the most common cases and they are sent as a return flow to STRs senders (art. 48, par 1).
“Patterns and diagrams” exemplify widespread, recurrent and abnormal behavior found by the UIF regarding certain sectors of activity or specific phenomena related to possible money laundering or terrorist financing.
These diagrams highlight particular logical-temporal sequences of events and behaviors based on previous analyses of criminal phenomena.
They are prepared on the basis of previous financial analyses and with the contribution of the competent investigating authorities and the supervisory bodies.

Following the list of “Anomaly Indicators” and “Patterns and diagrams representative of abnormal behavior” issued by the Italian AML authorities.

On September 14th 2015, the Italian Ministry of Economy and Finance (MEF) released the “2014 Report” on national preventive actions against money laundering and the financing of terrorism (pdf in Italian, 2.9 M, 142 pp.).
The 5th chapter (“The Supervisory activities”) illustrates controls carried out during 2014 by the UIF, the Italian FIU, the Bank of Italy, the Guardia di Finanza – the Italian financial police - and the DIA – Direzione Investigativa AntiMafia, Anti-Mafia Investigation Bureau.

On September 2nd, 2015 the UIF, the Financial Intelligence Unit (FIU) for Italy, issued a statement which introduces a new classification code for reporting of “Suspicious Activity Reports” – SARs related to potential money laundering transactions linked to the "voluntary disclosure" that is the rules for the emergence and the return of funds held abroad as stated by the law of 15th December 2014 n. 186.
As clarified by the note of January 9th, 2015 of the Italian Ministry of Finance (MEF), “the approval of voluntary disclosure rules has no impact on the application of money laundering legislation; therefore obligations of prevention provided by the Decree of 21 November 2007, n. 231 remain unchanged”.

On August 4th, 2015, the Financial Intelligence Unit for Italy (UIF) published the study “Tax havens: operational features, empirical evidence and financial anomalies”.
This study aims to map the so-called “tax havens” or “offshore financial centres”, that is, the countries which are non-cooperative to regard to taxation, financial supervision and anti-money laundering obligations.
The document also proposes some tools for the analysis of their financial flows.
The analysis focuses on a sample of 58 non-cooperative countries for which there are quantitative indicators to measure the level of opacity for each country, both overall and for corporate, tax and anti-money components.
The analysis shows that the 58 analyzed countries cover a major proportion of the cash flows both at a global and a national level.

Bank of Italy: updates of the provisions on Customer Due Diligence (CDD) and AUI (31 July 2015)

On July 31st, 2015, the Bank of Italy published the text of the amendments to the provisions of 3rd April 2013 on “Customer Due Diligence” (CDD) and AML recording in the “Single Financial Transactions Database” (AUI - Archivio Unico Informatico)
The amendments concern the AML requirements connected with the factoring of trade receivables and direct placement of mutual funds.

UIF, 2014 Report on Italian AML (July 13th, 2015)

On July 13th, 2015, the Financial Intelligence Unit for Italy (UIF) released its “Report on activities carried out in 2014” (pdf, 2.2 M, 109 pp.)
The report is accompanied by the "presentation" of Claudio Clemente, director of the UIF (here in pdf, 353 K, 20 pp) which summarizes the themes and findings from the Report.